Mifune Gets a Star on the Walk of Fame-the Petrobras Scandal Only Gets Worse

It was announced last week that actor Toshirō Mifune (1920-1997) will be honored with a star bearing his name on the Hollywood Walk of Fame. The Hollywood Chamber of Commerce will add the star in 2016, together with new stars in the motion picture category for Quentin Tarantino, Michael Keaton, Steve Carell, Bradley Cooper, Ashley Judd and Kurt Russell. For those of you who may not have heard of Mifune, he was a veteran of sixteen films directed by Akira Kurosawa as well as many other Japanese and international classics. His films with Kurosawa are considered cinema classics. They include Drunken Angel, Stray Dog, Rashomon, Seven Samurai, The Hidden Fortress, High and Low, Throne of Blood, Sanjuro, and Yojimbo. While there are many great, great performances in these films, my personal favorite is Yojimbo where Mifune plays an un-named Ronin, who cleans out a village infested by two warring clans. The film was the basis for the great first Sergio Leone/Clint Eastwood Spaghetti western, A Fistful of Dollars. 

I had always thought that the Hollywood Walk of Fame honors actors but it turns out that it honors a great many more performers. For instance, next year will also see names like LL Cool J, Cyndi Lauper, Shirley Caesar, Joseph B. “Joe” Smith, Itzhak Perlman, Adam Levine, and Bruno Mars added in the music category. I considered this category of entertainers wider than simply actors when I recently read more about the burgeoning scandal in Brazil around the state owned energy company Petrobras and its ever-growing fallout.

The fallout has extended far beyond Petrobras, Brazil and even the direct parties who may have been involved. In an article in the Financial Times (FT), entitled “Petrobras woes loom large in Shell deal for BG”, Joe Leahy, Jamie Smyth and Christopher Adams reported on how the ongoing matter is affecting the world of super sized mergers and acquisitions. The rather amazing thing about this issue is not that British Gas (BG) has been caught up in the scandal or even has been alleged to paying bribes to Petrobras.

Rather it is because of assets that BG has in its portfolio. The article said, “Brazil has the potential to become the location of the most troubled assets in BG’s portfolio because the UK company is partner to Petrobras in some of the vast pre-salt oilfields off the country’s east coast in the Santos Basin.” This has led to speculation that “There is a risk that Petrobras will struggle to fulfill its mandate as sole operator for all new pre-salt oilfields because of the corruption scandal, and that this leads to delays in developing the deepwater discoveries, including those involving BG.”

This development arising out of the Petrobras scandal is so significant that BG mentioned it in their annual report, saying “In Brazil, we are closely monitoring how the current corruption allegations affecting Petrobras may impact the cost and schedule of the Santos Basin [pre-salt] development because of supply chain disruption and/or capital and liquidity constraints placed on Petrobras.” Think about that statement for a moment. It is only in the annual report because it could have a ‘material’ effect on BG and BG is a company being acquired by Shell to the tune of £55 million. However, as noted in the FT article, “many analysts say that Petrobras, partly because of the magnitude of the scandal, does not have the capital or management bandwidth to be the sole operator of all new pre-salt fields.”

What if Petrobras becomes unable to develop enough resources to feed South America’s largest democracy’s need for energy? In 2014 alone, the company posted a new loss of $7.4 billion, of which $2.5 billion was attributable to the ongoing bribery and corruption scandal. How much will it cost the country of Brazil to bring in outsiders to develop its own natural resources? This is a real possibility and it was further driven home by another FT article by Joe Leahy, entitled “Petrobras plans 37% cut in investment”. Petrobras currently is required by Brazilian “government policy forcing it to import petrol at international prices and sell it in the domestic market at a subsidized rate.”

Things can only get worse as Leahy reported that the company announced it “was cutting its projection for investment in 2015-2019 to $130.3bn or by 37 percent in relation to its previous plan.” This would lead to a reduction in “domestic production to 2.8m barrels per day of oil equivalent by 2020 from the previous target of 4.2m.” The article ended by noting that Petrobras would “divest $15.1bn in assets and undertake additional restructuring and sales of assets totaling $42.6bn in 2017-18.”

All of this certainly bodes poorly for the citizens of Brazil. For those who claim that bribery is a victim-less crime; I would point to this as Contra-Example A. But this information is also of significance to any Chief Compliance Officer (CCO) or compliance practitioner for a US, UK or other western country. Not only must you review any contracts you had with Petrobras and any of its suppliers; now you must digger several levels deeper. If you are in an acquisition mode, you not only need to look at the contracts of your target to see if they may have been obtained through bribery and corruption, the simple fact of having a contract with Petrobras may put your potential portfolio asset base at risk. For if Petrobras has to cut back 37% on investments at this point, chances are it will only get much worse. This 37% reduction is based on only the first round of estimates of the cost to the company of the bribery scandal.

But more than simply contracts directly with Petrobras, if you are evaluating a target who has contracts with Petrobras suppliers, you may be at equal risk. Not only could those suppliers obtain their contracts with Petrobras through bribery and corruption, those same contracts, even if valid, may not be worth their estimated value if Petrobras cannot fulfill them or even worse, pay for the goods and services delivered thereunder. How about payment terms? Do think for one minute, Petrobras would not unilaterally extend payment dates out 30, 60, 90 even 180 days when it finds itself in more bribery and corruption hot water?

Finally, I think there is a very good chance the US Department of Justice (DOJ) or Securities and Exchange Commission (SEC) could come knocking, unannounced, for any US company doing business with Petrobras or even with significant operations in Brazil. The SEC could do something as simple as send a letter requesting clarification of your internal controls or books and records regarding subcontractors or other third parties in Brazil. If you received such a letter, would you be in position to respond from the requirements for a public company under the Foreign Corrupt Practices Act?

Toshirō Mifune had a long and distinguished acting career. While it is not clear how long, how far and how deep the Petrobras corruption scandal will reach, it is clear that its repercussions will extend far past the energy industry or even Brazil. You need to review and be prepared to respond now.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2015

Opinion Release 14-02: Dis-Linking The Illegal Conduct Going Forward

One of my favorite words in the context of Foreign Corrupt Practices Act (FCPA) enforcement is dis-link. I find it a useful adjective in explaining how certain conduct by a company must be separated from the winning of business. But it works on so many different levels when discussing the FCPA. Last week I thought about this concept of dis-linking when I read the second Opinion Release of 2014, that being 14-02. One of the clearest ways that the Department of Justice (DOJ) communicates is through the Opinion Release procedure. This procedure provides to the compliance practitioner solid and specific information about what steps a company needs to take in the pre-acquisition phase of due diligence. However, 14-02 directly answers many FCPA naysayers long incorrect claim about how companies step into FCPA liability through mergers and acquisitions (M&A) activity.

From the Opinion Release it was noted that the Requestor is a multinational company headquartered in the United States. Requestor desired to acquire a foreign consumer products company and it’s wholly owned subsidiary (collectively, the “Target”), both of which are incorporated and operate in a foreign country, never issuing securities in the United States. The Target had negligible business contacts in the US, including no direct sale or distribution of their products. In the course of its pre-acquisition due diligence of the Target, Requestor identified a number of likely improper payments by the Target to government officials of Foreign Country, as well as substantial weaknesses in accounting and recordkeeping. In light of the bribery and other concerns identified in the due diligence process, Requestor also detailed a plan for remedial pre-acquisition measures and post-acquisition integration steps. Requestor sought from the DOJ an Opinion as to whether the Department would then bring an FCPA enforcement action against Requestor for the Target’s pre-acquisition conduct. It was specifically noted that the Requestor did not seek an Opinion from the Department as to Requestor’s criminal liability for any post-acquisition conduct by the Target.

Improper Payments and Compliance Program Weaknesses

In preparing for the acquisition, Requestor undertook due diligence aimed at identifying, among other things, potential legal and compliance concerns at the Target. Requestor retained an experienced forensic accounting firm (“the Accounting Firm”) to carry out the due diligence review. This review brought to light evidence of apparent improper payments, as well as substantial accounting weaknesses and poor recordkeeping. The Accounting Firm reviewed approximately 1,300 transactions with a total value of approximately $12.9 million with over $100,000 in transactions that raised compliance issues. The vast majority of these transactions involved payments to government officials related to obtaining permits and licenses. Other transactions involved gifts and cash donations to government officials, charitable contributions and sponsorships, and payments to members of the state-controlled media to minimize negative publicity. None of the payments, gifts, donations, contributions, or sponsorships occurred in the US, none were made by or through a US person or issuer and apparently none went through a US bank.

The due diligence showed that the Target had significant recordkeeping deficiencies. Nonetheless, documentary records did not support the vast majority of the cash payments and gifts to government officials and the charitable contributions. There were expenses that were improperly and inaccurately classified. It was specifically noted that the accounting records were so disorganized that the Accounting Firm was unable to physically locate or identify many of the underlying records for the tested transactions. Finally, the Target had not developed or implemented a written code of conduct or other compliance policies and procedures, nor did the Target’s employees show an adequate understanding or awareness of anti-bribery laws and regulations.

Post-Acquisition Remediation

The Requestor presented several pre-closing steps to begin to remediate the Target’s weaknesses prior to the planned closing in 2015. Requestor aimed to complete the full integration of the Target into Requestor’s compliance and reporting structure within one year of the closing. Requestor has set forth an integration schedule of the Target that included various risk mitigation steps, dissemination and training with regard to compliance procedures and policies, standardization of business relationships with third parties, and formalization of the Target’s accounting and record-keeping in accordance with Requestor’s policies and applicable law.

DOJ Analysis

The DOJ noted black-letter letter when it stated, ““It is a basic principle of corporate law that a company assumes certain liabilities when merging with or acquiring another company. In a situation such as this, where a purchaser acquires the stock of a seller and integrates the target into its operations, successor liability may be conferred upon the purchaser for the acquired entity’s pre-existing criminal and civil liabilities, including, for example, for FCPA violations of the target. However this is tempered by the following from the 2012 FCPA Guidance, “Successor liability does not, however, create liability where none existed before. For example, if an issuer were to acquire a foreign company that was not previously subject to the FCPA’s jurisdiction, the mere acquisition of that foreign company would not retroactively create FCPA liability for the acquiring issuer.””

This means that because none of the payments were made in the US, none went through the US banking system and none involved a US person or entity that this would not lead to a creation of liability for the acquiring company. Moreover, there would be no continuing or ongoing illegal conduct going forward because “no contracts or other assets were determined to have been acquired through bribery that would remain in operation and from which Requestor would derive financial benefit following the acquisition.” Therefore there would be no jurisdiction under the FCPA to prosecute any person or entity involved after the acquisition.

The DOJ also provided this additional information, “To be sure, the Department encourages companies engaging in mergers and acquisitions to (1) conduct thorough risk-based FCPA and anti-corruption due diligence; (2) implement the acquiring company’s code of conduct and anti-corruption policies as quickly as practicable; (3) conduct FCPA and other relevant training for the acquired entity’s directors and employees, as well as third-party agents and partners; (4) conduct an FCPA-specific audit of the acquired entity as quickly as practicable; and (5) disclose to the Department any corrupt payments discovered during the due diligence process. See FCPA Guide at 29. Adherence to these elements by Requestor may, among several other factors, determine whether and how the Department would seek to impose post-acquisition successor liability in case of a putative violation.”

Discussion

Mike Volkov calls it ‘reading the tea leaves’ when it comes to what information the DOJ is communicating. However, sometimes I think it is far simpler. First, and foremost, 14-02 communicates that there is no such thing as ‘springing liability’ to an acquiring company in the FCPA context nor such a thing as simply buying a FCPA violation, simply through an acquisition only, there must be continuing conduct for FCPA liability to arise. Most clearly beginning with the FCPA Guidance, the DOJ and Securities and Exchange Commission (SEC) have communicated what companies need to do in any M&A environment. While many compliance practitioners had only focused on the post-acquisition integration and remediation; the clear import of 14-02 is to re-emphasize importance of the pre-acquisition phase.

Your due diligence must being in the pre-acquisition phase. The steps taken by the Requestor in this Opinion Release demonstrate some of the concrete steps that you can take. Some of the techniques you can use in the pre-acquisition phase include (1) having your internal or external legal, accounting, and compliance departments review a target’s sales and financial data, its customer contracts, and its third-party and distributor agreements; (2) performing a risk-based analysis of a target’s customer base; (3) performing an audit of selected transactions engaged in by the target; and (4) engaging in discussions with the target’s general counsel, vice president of sales, and head of internal audit regarding all corruption risks, compliance efforts, and any other major corruption-related issues that have surfaced at the target over the past ten years.

Whether you can make these inquiries or not, you will also need to engage in post-acquisition integration and remediation. 14-02 provides you with some of the steps you need to perform after the transaction is closed. If you cannot perform any or even an adequate pre-acquisition due diligence, the time frames you put in place after the acquisition closes may need to be compressed to make sure that you are not continuing any nefarious FCPA conduct going forward. But it all goes back to dis-linking. If a target is engaging in conduct that violates the FCPA but the target itself is not subject to the jurisdiction of the FCPA, you simply cannot afford to allow that conduct to continue. If you do allow such conduct to continue you will have bought a FCPA violation and your company will be actively engaging and participating in an ongoing FCPA violation. That is the final takeaway I derive from this Opinion Release; it is allowing corruption and bribery to continue which brings companies into FCPA grief. Opinion Release 14-02 provides you a roadmap of the steps you and your company can take to prevent such FCPA exposure.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

Mergers and Acquisitions Under the FCPA, Part III

Today I conclude my three-part series on mergers and acquisitions under the Foreign Corrupt Practices Act (FCPA) with a review of the post-acquisition phase.

Previously many compliance practitioners had based decisions in the M&A context on DOJ Opinion Release 08-02 (08-02), which related to Halliburton’s proposed acquisition of the UK entity, Expro. In the spring of 2011, the Johnson & Johnson (J&J) DPA changed the perception of compliance practitioners regarding what is required of a company in the M&A setting related to FCPA due diligence, both pre and post-acquisition. On June 18 2012, the DOJ released the Data Systems & Solutions LLC (DS&S) DPA which brought additional information to the compliance practitioner on what a company can do to protect itself in the context of M&A activity.

08-02 began as a request from Halliburton to the DOJ from issues that arose in the pre-acquisition due diligence of the target company Expro. Halliburton had submitted a request to the DOJ specifically posing these three questions: (1) whether the proposed acquisition transaction itself would violate the FCPA; (2) whether, through the proposed acquisition of Target, Halliburton would “inherit” any FCPA liabilities of Target for pre-acquisition unlawful conduct; and (3) whether Halliburton would be held criminally liable for any post-acquisition unlawful conduct by Target prior to Halliburton’s completion of its FCPA and anti-corruption due diligence, where such conduct is identified and disclosed to the Department within 180 days of closing.

I. Halliburton 

Halliburton committed to the following conditions in 08-02, if it was the successful bidder in the acquisition:

1. Within ten business days of the closing. Halliburton would present to the DOJ a comprehensive, risk-based FCPA and anti-corruption due diligence work plan which would address, among other things, the use of agents and other third parties; commercial dealings with state-owned customers; any joint venture, teaming or consortium arrangements; customs and immigration matters; tax matters; and any government licenses and permits. The Halliburton work plan committed to organizing the due diligence effort into high risk, medium risk, and lowest risk elements.

a)     Within 90 days of Closing. Halliburton would report to the DOJ the results of its high risk due diligence.

b)    Within 120 days of Closing. Halliburton would report to the DOJ the results to date of its medium risk due diligence.

c)     Within 180 days of Closing. Halliburton would report to the DOJ the results to date of its lowest risk due diligence.

d)    Within One Year of Closing. Halliburton committed full remediation of any issues which it discovered within one year of the closing of the transaction.

Many lawyers were heard to exclaim, “What an order, we cannot go through with it.” However, we advised our clients not to be discouraged because 08-02 laid out a clear road map for dealing with some of the difficulties inherent in conducting sufficient pre-acquisition due diligence in the FCPA context. Indeed the DOJ concluded 08-02 by noting, “Assuming that Halliburton, in the judgment of the Department, satisfactorily implements the post-closing plan and remediation detailed above… the Department does not presently intend to take any enforcement action against Halliburton.”

II.Johnson & Johnson (J&J)

In Attachment D of the J&J DPA, entitled “Enhanced Compliance Obligations”, there is a list of compliance obligations in which J&J agreed to undertake certain enhanced compliance obligations for at least the duration of its DPA beyond the minimum best practices also set out in the J&J DPA. With regard to the M&A context, J&J agreed to the following:

7. J&J will ensure that new business entities are only acquired after thorough FCPA and anti-corruption due diligence by legal, accounting, and compliance personnel. Where such anti-corruption due diligence is not practicable prior to acquisition of a new business for reasons beyond J&J’s control, or due to any applicable law, rule, or regulation, J&J will conduct FCPA and anti-corruption due diligence subsequent to the acquisition and report to the Department any corrupt payments, falsified books and records, or inadequate internal controls as required by … the Deferred Prosecution Agreement.
8. J&J will ensure that J&J’s policies and procedures regarding the anti-corruption laws and regulations apply as quickly as is practicable, but in any event no less than one year post-closing, to newly-acquired businesses, and will promptly, for those operating companies that are determined not to pose corruption risk, J&J will conduct periodic FCPA Audits, or will incorporate FCPA components into financial audits.
9. Train directors, officers, employees, agents, consultants, representatives, distributors, joint venture partners, and relevant employees thereof, who present corruption risk to J&J, on the anticorruption laws and regulations and J&J’s related policies and procedures; and
10. Conduct an FCPA-specific audit of all newly acquired businesses within 18 months of acquisition.

These enhanced obligations agreed to by J&J in the M&A context were less time sensitive than those agreed to by Halliburton in 08-02. In the J&J DPA, the company agreed to the following time frames:

1. 18 Month – conduct a full FCPA audit of the acquired company.

1. 12 Month – introduce full anti-corruption compliance policies and procedures into the acquired company and train those persons and business representatives which “present corruption risk to J&J.”

III. Data Systems & Solutions LLC (DS&S)

In the DS&S DPA there were two new items listed in the Corporate Compliance Program, attached as Schedule C to the DPA, rather than the standard 13 items we have seen in every DPA since at least November 2010. The new additions are found on items 13 & 14 on page C-6 of Schedule C and deal with mergers and acquisitions. They read in full:

3. DS&S will develop and implement policies and procedures for mergers and acquisitions requiring that DS&S conduct appropriate risk-based due diligence on potential new business entities, including appropriate FCPA and anti-corruption due diligence by legal, accounting, and compliance personnel. If DS&S discovers any corrupt payments or inadequate internal controls as part of its due diligence of newly acquired entities or entities merged with DS&S, it shall report such conduct to the Department as required in Appendix B of this Agreement.
4. DS&S will ensure that DS&S’s policies and procedures regarding the anticorruption laws apply as quickly as is practicable to newly acquired businesses or entities merged with DS&S and will promptly:
5. Train directors, officers, employees, agents, consultants, representatives, distributors, joint venture partners, and relevant employees thereof, who present corruption risk to DS&S, on the anti-corruption laws and DS&S’s policies and procedures regarding anticorruption laws.
6. Conduct an FCPA-specific audit of all newly acquired or merged businesses as quickly as practicable.

This language draws from and builds upon the prior Opinion Release 08-02 regarding Halliburton’s request for guidance and the J&J “Enhanced Compliance Obligations” incorporated into its DPA. While the DS&S DPA does note that it is specifically tailored as a solution to DS&S’s FCPA compliance issues, I believe that this is the type of guidance that a compliance practitioner can rely upon when advising his or her clients on what the DOJ expects during M&A activities.

 

FCPA M&A Box Score Summary

Time Frames	Halliburton 08-02	J&J	DS&S
FCPA Audit	High Risk Agents – 90 days Medium Risk Agents – 120 Days Low Risk Agents – 180 days	18 months to conduct full FCPA audit	As soon “as practicable”
Implement FCPA Compliance Program	Immediately upon closing	12 months	As soon “as practicable”
Training on FCPA Compliance Program	60 days to complete training for high risk employees, 90 days for all others	12 months to complete training	As soon “as practicable”

 

The Guidance, coupled with the 08-02 and the two enforcement actions, speak to the importance that the DOJ puts on M&A in the FCPA context. The time frames for post-acquisition integration are quite tight. This means that you should do as much work as you can in the pre-acquisition stage. The DOJ makes clear that rigor is needed throughout your entire compliance program, including M&A. This rigor should be viewed as something more than just complying with the FCPA; it should be viewed as just making good business sense.

Nat Edmonds, in an interview in the Wall Street Journal (WSJ) entitled, “Former Justice Official: How to Buy Corrupt Companies”, emphasized that if a company does not have the opportunity to make these types of inquiries in the pre-acquisition stage the “DOJ and SEC generally recognize that sometimes it’s not possible to do complete due diligence beforehand. However, if there are good faith efforts to conduct due diligence, integrate compliance programs and take remedial actions by removing those wrongdoers — if all of that is done on a quick basis [authorities] give very strong credit. The best example of this is the 2009 purchase by Pfizer of Wyeth. I was prosecutor on the Pfizer Wyeth [bribery] case. Pfizer was able to do some due diligence before the acquisition but because both are massive organizations it was not possible to do complete due diligence prior to acquisition. But after the acquisition within 180 days they had identified much of the wrongdoing at Wyeth and ensured it was halted. As a result of that we gave them credit. On the criminal side Pfizer was not held criminally liable for any of the conduct at Wyeth. Most of what Pfizer was held responsible for was as a result of a previous acquisition of Pharmacia, which they acquired in 2002 and 2003. At the time of the Pharmacia acquisition, acquirers did not typically conduct anti-corruption due diligence on targets. And during the investigation most of the violations of FCPA [Pfizer] was held criminally liable for began prior to the acquisition of Pharmacia –some was afterwards. Pfizer was held responsible for the misconduct at Pharmacia both before and afterwards. The Pfizer case is interesting because it shows both the good and bad.”

I believe that he information is out there for the steps to take in a merger or acquisition to avoid FCPA liability. You should place emphasis on both the pre and post acquisition phases; equally because as with most FCPA compliance program components, they just make good business sense.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

Mergers and Acquisitions Under the FCPA, Part II

Yesterday I began a three part series on mergers and acquisitions under the Foreign Corrupt Practices Act (FCPA). In Part I, I reviewed what you should accomplish in the pre-acquisition stage. Today I want to look at what you should do with the information that you obtain in your pre-acquisition compliance due diligence.

Jay Martin, Chief Compliance Officer (CCO) at BakerHughes Inc. suggests an approach that reviews key risk factors to move forward. Martin has laid out 15 key risk factors of targets under a FCPA analysis, which he believes should prompt a purchaser to conduct extra careful, heightened due diligence or even reconsider moving forward with an acquisition under extreme circumstances.

1. A presence in a BRIC (Brazil, Russia, India and China) country and other countries whose corruption risk is high, for example, a country with a Transparency International CPI rating of 5 or less;
2. Participation in an industry that has been the subject of recent anti-bribery or FCPA investigations, for example, in the oil and energy, telecommunications, or pharmaceuticals sectors;
3. Significant use of third-party agents, for example, sales representatives, consultants, distributors, subcontractors, or logistics personnel (customs, visas, freight forwarders, etc.)
4. Significant contracts with a foreign government or instrumentality, including state-owned or state-controlled entities;
5. Substantial revenue from a foreign government or instrumentality, including a state-owned or state-controlled entity;
6. Substantial projected revenue growth in the foreign country;
7. High amount or frequency of claimed discounts, rebates, or refunds in the foreign country;
8. A substantial system of regulatory approval, for example, for licenses and permits, in the country;
9. A history of prior government anti-bribery or FCPA investigations or prosecutions;
10. Poor or no anti-bribery or FCPA training;
11. A weak corporate compliance program and culture, in particular from legal, sales and finance perspectives at the parent level or in foreign country operations;
12. Significant issues in past FCPA audits, for example, excessive undocumented entertainment of government officials;
13. The degree of competition in the foreign country;
14. Weak internal controls at the parent or in foreign country operations; and
15. In-country managers who appear indifferent or uncommitted to U.S. laws, the FCPA, and/or anti-bribery laws.

In evaluating answers to the above inquiries or those you might develop on your own, you may also wish to consider some type of risk rating for the responses, to better determine is the amount of risk that your company is willing to accept to do so you will need to both assess risk and subsequently evaluate that risk. Borrowing from a matrix developed by Michele Abraham from Timken Co., I have found Timken’s matrix for risk rating and assessment useful. Risks should initially be identified and then plotted on a heat map to determine their priority. The most significant risks with the greatest likelihood of occurring are deemed the priority risks, which become the focus of the your post-acquisition remediation plan going forward. A risk-rating guide similar to the following can be used.

LIKELIHOOD

Likelihood Rating	Assessment	Evaluation Criteria
1	Almost Certain	High likely, this event is expected to occur
2	Likely	Strong possibility that an event will occur and there is sufficient historical incidence to support it
3	Possible	Event may occur at some point, typically there is a history to support it
4	Unlikely	Not expected but there’s a slight possibility that it may occur
5	Rare	Highly unlikely, but may occur in unique circumstances

 

‘Likelihood’ factors to consider: The existence of controls, written policies and procedures designed to mitigate risk capable of leadership to recognize and prevent a compliance breakdown; Compliance failures or near misses; Training and awareness programs. Product of ‘likelihood’ and significance ratings reflects the significance of particular risk universe. It is not a measure of compliance effectiveness or to compare efforts, controls or programs against peer groups.

The key to such an approach is the action steps prescribed by their analysis. This is another way of saying that the pre-acquisition risk assessment informs the post-acquisition remedial actions to the target’s compliance program. This is the method set forth in the FCPA Guidance. I believe that the DOJ wants to see a reasoned approach with regards to the actions a company takes in the mergers and acquisitions arena. The model set forth by Michele Abraham of Timken certainly is a reasoned approach and can provide the articulation needed to explain which steps were taken.

It is also important that after the due diligence is completed, and if the transaction moves forward, the acquiring company should attempt to protect itself through the most robust contract provisions that it can obtain, these would include indemnification against possible FCPA violations, including both payment of all investigative costs and any assessed penalties. An acquiring company should also include reps and warranties in the final sales agreement that the entire target company uses for participation in transactions as permitted under local law; that there is an absence of government owners in company; and that the target company has made no corrupt payments to foreign officials. Lastly, there must be a rep that all the books and records presented to the acquiring company for review were complete and accurate.

To emphasize all of the above, the DOJ stated in the Pfizer Deferred Prosecution Agreement (DPA), in the mergers and acquisition context, that a company is to ensure that, when practicable and appropriate on the basis of a FCPA risk assessment, new business entities are only acquired after thorough risk-based FCPA and anti-corruption due diligence is conducted by a suitable combination of legal, accounting, and compliance personnel. When such anti-corruption due diligence is appropriate but not practicable prior to acquisition of a new business for reasons beyond a company’s control, or due to any applicable law, rule, or regulation, an acquiring company should continue to conduct anti-corruption due diligence subsequent to the acquisition and report to the DOJ any corrupt payments or falsified books and records.

Tomorrow in Part III, I will take a look at your post-acquisition actions in the mergers and acquisition context.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

Mergers and Acquisitions Under the FCPA, Part I

Today, I begin a three-part series on mergers and acquisitions under the Foreign Corrupt Practices Act. Today I will review the pre-acquisition phase, focusing the information and issues you should review, tomorrow in Part II, I will look at how you should use that information in the evaluation process and in Part III, I will consider steps you should take in the post-acquisition phase.

The Foreign Corrupt Practices Act (FCPA) Guidance, issued in 2012, makes clear that one of the ten hallmarks of an effective compliance program is around mergers and acquisitions (M&A), in both the pre and post-acquisition context. A company that does not perform adequate FCPA due diligence prior to a merger or acquisition may face both legal and business risks. Perhaps, most commonly, inadequate due diligence can allow a course of bribery to continue – with all the attendant harms to a business’s profitability and reputation, as well as potential civil and criminal liability. In contrast, companies that conduct effective FCPA due diligence on their acquisition targets are able to evaluate more accurately each target’s value and negotiate for the costs of the bribery to be borne by the target. But, equally important is that if a company engages in the suggested actions, they will go a long way towards insulating, or at least lessening, the risk of FCPA liability going forward.

Nat Edmonds, in an interview in the Wall Street Journal (WSJ) entitled, “Former Justice Official: How to Buy Corrupt Companies” said “I think most companies and their outside counsel believe any potential corruption problem should stop a deal from occurring. Companies would be surprised to learn that neither the Securities and Exchanges Commission nor the DOJ takes that position. In many ways the SEC and DOJ encourage good companies with strong compliance programs to buy the companies engaged in improper conduct in order to help implement strong compliance in companies that have engaged in wrongful conduct. What companies must do and what outside counsel should advise them to do is to have a realistic perspective of what effect that corruption or potential improper payment has on the value of the deal itself. Because of the concern that any corruption would stop the deal or implicate the buyers, many times companies don’t look as thoroughly as they should at potential corruption. There is often concern that if you start to look for something you may find a problem and it could slow down or stop the whole deal.”

The FCPA Guidance was the first time that many compliance practitioners focused on the pre-acquisition phase of a transaction as part of a compliance regime. However, the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) made clear the importance of this step. In addition to the above language, they cited to another example in the section on Declinations where the “DOJ and SEC declined to take enforcement action against a U.S. publicly held consumer products company in connection with its acquisition of a foreign company.” The steps taken by the company led the Guidance to state the following, “The company identified the potential improper payments to local government officials as part of its pre-acquisition due diligence and the company promptly developed a comprehensive plan to investigate, correct, and remediate any FCPA issues after acquisition.”

In a hypothetical, the FCPA Guidance provided some specific steps a company had taken in the pre-acquisition phase. These steps included, “(1) having its legal, accounting, and compliance departments review Foreign Company’s sales and financial data, its customer contracts, and its third-party and distributor agreements; (2) performing a risk-based analysis of Foreign Company’s customer base; (3) performing an audit of selected transactions engaged in by Foreign Company; and (4) engaging in discussions with Foreign Company’s general counsel, vice president of sales, and head of internal audit regarding all corruption risks, compliance efforts, and any other corruption-related issues that have surfaced at Foreign Company over the past ten years.”

Pre-Acquisition Risk Assessment

It should all begin with a preliminary pre-acquisition assessment of risk. Such an early assessment will inform the transaction research and evaluation phases. This could include an objective view of the risks faced and the level of risk exposure, such as best/worst case scenarios. A pre-acquisition risk assessment could also be used as a “lens through which to view the feasibility of the business strategy” and help to value the potential target.

The next step is to develop the risk assessment as a base document. From this document, you should be able to prepare a focused series of queries and requests to be obtained from the target company. Thereafter, company management can use this pre-acquisition risk assessment to attain what might be required in the way of integration, post-acquisition. It would also help to inform how the corporate and business functions may be affected. It should also assist in planning for timing and anticipation of the overall expenses involved in post-acquisition integration. These costs are not insignificant and they should be thoroughly evaluated in the decision-making calculus.

Next is a five step process on how to plan and execute a strategy to perform pre-acquisition due diligence in the M&A context.

1. Establish a point of contact. Here you need to determine one point of contact that you can liaise with throughout the process. Typically this would be the target’s Chief Compliance Officer (CCO) if the company is large enough to have full time position.
2. Collect relevant documents. Obtain a detailed list of sales going back 3-5 years, broken out by country and, if possible, obtain a further breakdown by product and/or services; all Joint Venture (JV) contracts, due diligence on JVs and other third party business partners; the travel and entertainment records of the acquisition target company’s top sales personnel in high risk countries; internal audit reports and other relevant documents. You do not need to investigate de minimis sales amounts but focus your compliance due diligence inquiry on high sales volumes in high-risk countries. If the acquisition target company uses a sales model of third parties, obtain a complete list, including JVs. It should be broken out by country and amount of commission paid. Review all underlying due diligence on these foreign business representatives, their contracts and how they were managed after the contract was executed; your focus should be on large commissions in high risk countries.
3. Review the compliance and ethics mission and goals. Here you need to review the Code of Conduct or other foundational documents that a company might have to gain some insight into what they publicly espouse.
4. Review the seven elements of an effective compliance program as listed below:

a. Oversight and operational structure of the compliance program. Here you should assess the role of board, CCO and if there is one, the compliance committee. Regarding the CCO, you need to look at their reporting and access – is it independent within the overall structure of the company? Also, what are the resources dedicated to the compliance program including a review of personnel, the budget and overall resources? Review high-risk geographic areas where your company and the acquisition target company do business. If there is overlap, seek out your own sales and operational people and ask them what compliance issues are prevalent in those geographic areas. If there are compliance issues that your company faces, then the target probably faces them as well.

b. Policies/Procedures, Code of Conduct. In this analysis you should identify industry practices and legal standards that may exist for the target company. You need to review how the compliance policies and procedures were developed and determine the review cycles, if any. Lastly, you need to know how everything is distributed and what the enforcement mechanisms for compliance policies are. Additionally you need to validate, with Human Resources (HR), if there have been terminations or disciplines relating to compliance.cEducation, training and communication. Here you need to review the compliance training process, as it exists in the company, both the formal and the informal. You should ask questions, such as “What are the plans and schedules for compliance training?” Next determine if the training material itself is fit for its intended purpose, including both internal and external training for third parties. You should also evaluate the training delivery channels, for example is the compliance training delivered live, online, or through video? Finally, assess whether the company has updated their training based on changing of laws. You will need to interview the acquisition target company personnel responsible for its compliance program to garner a full understanding of how they view their program. Some of the discussions that you may wish to engage in include visiting with the target company’s General Counsel (GC), its Vice President (VP) of sales and head of internal audit regarding all corruption risks. You should also delve into the target’s compliance efforts, and any other corruption-related issues that may have surfaced.

c. Monitoring and auditing. Under this section you need to review both the internal audit plan and methodology used regarding any compliance audits. A couple of key points are (1) is it consistent over a period of time and (2) what is the audit frequency? You should also try and judge whether the audit is truly independent or if there was manipulation by the business unit(s). You will need to review the travel and entertainment records of the acquisition target company’s top sales personnel in high-risk countries. You should retain a forensic auditing firm to assist you with this effort. Use the resources of your own company personnel to find out what is reasonable for travel and entertainment in the same high-risk countries which your company does business.

d. Reporting. What is the company’s system for reporting violations or allegations of violations? Is the reporting system anonymous? From there you need to turn to who does the investigations to determine how are they conducted? A key here, as well as something to keep in mind throughout the process, is the adequacy of record keeping by the target.

e. Response to detected violations. This review is to determine management’s response to detected violations. What is the remediation that has occurred and what corrective action has been taken to prevent future, similar violations? Has there been any internal enforcement and discipline of compliance policies if there were violations? Lastly, what are the disclosure procedures to let the relevant regulatory or other authorities know about any violations and the responses thereto? Further, you may be required to self-disclose any FCPA violations that you discover. There may be other reporting issues in the M&A context such as any statutory obligations to disclose violations of any anti-bribery or anti-corruption laws in the jurisdiction(s) in question; what effect will disclosure have on the target’s value or the purchase price that your company is willing to offer?

f. Enforcement Practices/Disciplinary Actions. Under this analysis, you need to see if there was any discipline delivered up to and including termination. If remedial measures were put in place, how were they distributed throughout the company and were they understood by employees?

5. Periodically evaluate the M&A review procedures’ effectiveness benchmarked against any legal proceedings, FCPA enforcement actions, Opinion Releases or other relevant information.

Tomorrow, I will review how you use the information that you are able to obtain in the pre-acquisition process.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

Watergate is Not Just a Hotel – Corporate Suitors for Alstom

Today is the anniversary of an event that can truly be said to have changed the world; although certainly not in the manner intended by its planners, sponsors or participants. Today is the anniversary of the 1972 Watergate Break-In. How much of the world has changed because of this event? We certainly would not have had Jimmy Carter as the US President and most probably would not have had the Foreign Corrupt Practices Act (FCPA) passed into law during his administration. Would Ronald Reagan have become President four years earlier in 1976 rather than 1980? Who knows, but, if yes, would the Soviet Union have collapsed sooner under the weight of his military buildup? What about the fall of the Shah and the taking of the US hostages, think Reagan would have had a more ‘robust’ response than Carter? All tantalizing questions for those interested in the great What Ifs of history.

Over the weekend, I read that the long shuttered Watergate complex is scheduled to be torn down to make way for a more modern office edifice in its most desirable of Washington DC locations. This reminded me of one of my favorite Watergate era slogans “And Watergate was not just a hotel!” Indeed it was not just a building, rather an entire mindset of a presidency that went seriously off the rails.

Interestingly I found a parallel to this slogan when reading about the overtures by General Electric (GE), then Siemens and also Mitsubishi Heavy Industries to purchase some or all of the French company Alstom. These offers are in spite of Alstom’s very public current anti-corruption issues, in several countries. Mike Volkov, in a blog post entitled “Alstom: The Next Poster Child for Anti-Corruption Enforcement”, said “In our FCPA world, we have a new poster child for blundering – Alstom. The handwriting is on the wall – as time goes on, the Justice Department is building a bigger and bigger FCPA case against Alstom. One of my favorite Dylan lyrics applies with full force – “You don’t need a weatherman to know which way the wind blows.” Further, “Clearly we have a case where the client company just does not understand what is going on, nor does senior leadership have the ability or desire to respond and fix the problems. Instead, Alstom’s failure to act and respond reflects the lack of any ethical culture. That in a nutshell is probably 90 percent of the reason that a culture of bribery took over the company.” Pretty strong stuff.

Four senior executives have been charged for FCPA violations around one project. The FCPA Professor reported, “The conduct at issue concerned the Tarahan coal-fired steam power plant project in Indonesia.” All were charged around the same set of facts. They are alleged to have paid bribes to officials in Indonesia, including a member of Indonesian Parliament and high-ranking members of Perusahaan Listrik Negara (PLN), the state-owned and state-controlled electricity company, in exchange for those officials’ assistance in securing a contract for the company to provide power-related services for the citizens of Indonesia, known as the Tarahan project.” Two of the four Alstom executives have pled guilty to FCPA violations.

Over the weekend, the Financial Times (FT) reported, in an article by Caroline Binham, entitled “UK prosecutors press on with Alstom probe”, that the Serious Fraud Office (SFO) has been given permission by the UK attorney-general to prosecute both the company and former employees for allegations of overseas bribery. The SFO “has also notified seven individuals but is considering whether to prosecute them after they were interviewed with the assistance of French authorities, people familiar with the investigation told the Financial Times…Among those who received letters from the SFO are the company’s former senior vice-president of ethics and compliance, Jean-Daniel Lainé, and three Britons who formerly held senior management positions: Graham Hall, Robert Hallett and Nicholas Reynolds.” All of the individuals identified in the FT article do not appear to have been a part of the Indonesia power project, which appears to form the basis of the FCPA charges here in the US.

So why such high level suitors for a company of which Volkov has opined, “It is an important reminder of how bad a company’s culture can become and the consequences of embracing a culture of lawlessness versus a culture of ethics and integrity.” What about all that ‘Springing Liability’ for which both Siemens and GE might be liable for if they are successful in purchasing some or all of Alstom that the US Chamber of Commerce and others rail about? I think that the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) answered these questions in the FCPA Guidance when they stated, “companies that conduct effective FCPA due diligence on their acquisition targets are able to evaluate more accurately each target’s value and negotiate for the costs of the bribery to be borne by the target. In addition, such actions demonstrate to DOJ and SEC a company’s commitment to compliance and are taken into account when evaluating any potential enforcement action.” But pre-acquisition work is only one part of the equation, as the FCPA Guidance goes on to state, “FCPA due diligence, however, is normally only a portion of the compliance process for mergers and acquisitions. DOJ and SEC evaluate whether the acquiring company promptly incorporated the acquired company into all of its internal controls, including its compliance program.Companies should consider training new employees, reevaluating third parties under company standards, and, where appropriate, conducting audits on new business units.”

One thing that GE and Siemens have in common are world-class compliance programs. Siemens was the subject of the highest FCPA fine ever at $800MM back in 2008. Since that time, it has successfully concluded a robust monitorship under the terms of its Deferred Prosecution Agreement (DPA). Siemens compliance representatives regularly speak at compliance related events and discuss not only the company’s commitment to anti-corruption compliance but they also detail how compliance is done at Siemens. GE is well known for having its compliance folks regularly speak at conferences about the details of its compliance regime. In other words, both companies’ have very public robust compliance regimes in place and most probably follow, at a minimum, the parameters set out in the FCPA Guidance.

Just as “And Watergate is not just a hotel!”; Springing Liability is not a warranted fear under the FCPA. The FCPA Guidance makes clear the steps a company should engage in under the FCPA to avoid liability in a mergers and acquisition (M&A) context. The steps are not only relatively straightforward; they are good business steps to take. If you do not know what you are looking to acquire, it is certainly hard to evaluate it properly and then to integrate it efficiently.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com. 

© Thomas R. Fox, 2014

Shifting Sands In Canadian Anti-bribery And Trade Control Laws Raise The Stakes In M&A Due Diligence

Ed. Note-I recently saw an article on M&A compliance due diligence, from the Canadian perspective, by John Boscariol. I asked John if I could repost his article, which he graciously allowed me to do. 

Recent developments in Canadian anti-corruption, economic sanctions, and export control laws are having a significant impact on the due diligence that should be conducted on potential targets in the context of mergers and acquisitions as well as other business combinations such as joint ventures. 

New and expanding measures along with increased enforcement, particularly in the resource extraction industries such as energy and mining, have raised the stakes for those investing in Canadian companies. Today, it is becoming more common for potential acquirers or investors to delay, re-price or even walk away from transactions because of actual or perceived compliance failures in the target’s operations.

A misstep in this area can have significant ramifications – in addition to criminal prosecution and penalties, compliance failures can also result in significant expenditure on internal investigations, the inability to move product or transfer technology cross-border, delayed or cancelled customer orders, debarment from doing business with government, and substantial reputational costs in relationships with business partners, including banks, investors, customers, suppliers and other stakeholders. Further, the now well-established pattern in the United States of shareholder class action suits being launched following allegations of management failure to implement proper internal controls is beginning to take hold in Canada.

Canadian authorities becoming more aggressive

In recent years, Canadian authorities responsible for implementation and enforcement of trade controls and anti-corruption laws – including the Royal Canadian Mounted Police (RCMP), the Canada Border Services Agency, Foreign Affairs and International Trade Canada, and Crown prosecutors – have stepped up their game.

Canada’s experience in the anti-corruption sphere is a good example. After many years without any significant enforcement, in 2008 the RCMP formed a special unit responsible for the enforcement of the Corruption of Foreign Public Officials Act (CFPOA). In June of 2011, Nike Resources was convicted of violating the CFPOA and penalised $9.5m. In January of this year, Griffiths Energy was also convicted and fined $10.35m. At the present time, it is understood that the RCMP is conducting over 35 investigations of Canadian companies and individuals suspected of CFPOA violations.

Five areas deserving special attention for due diligence

Although not intended to be exhaustive, the following are five areas where you should at least initially focus before drilling down into any specific matters of concern:

Where is the target doing business? Identifying countries with which the target does business is critical to assessing risk exposure from both the anti-corruption and trade control perspective. Where are their customers, suppliers, licensees/licensors creditors and other business partners located?

Canada currently maintains trade controls of varying degrees of aggressiveness in respect of activities involving Belarus, Burma, Côte d’Ivoire, the Democratic Republic of the Congo, Cuba, Egypt, Eritrea, Guinea-Bissau, Iran, Iraq, Lebanon, Liberia, Libya, North Korea, Pakistan, Sierra Leone, Somalia, Sudan, Syria, Tunisia and Zimbabwe. Activities in these countries with entities based in these countries should be carefully reviewed to ensure compliance with economic sanctions and export controls.

Location also plays a significant role in assessing anti-corruption compliance risk. Developing or newly industrialised countries in Africa, the Middle East, Asia, and areas of Latin America are particularly vulnerable to corruption. Independent country rankings of corruption risk, including Transparency International’s Corruption Perceptions Index, are a helpful starting point.

What are the target’s ‘government touch-points’?Understanding how your target deals with government on a daily basis helps assess the exposure to potential opportunities for government corruption. This includes dealings with government owned entities, including commercial enterprises. Getting a list of the target’s government customers and suppliers is an obvious and important starting point.

It is also necessary to determine what licences or permits are required for the target’s operations and review its dealing in the negotiation of concessions, production sharing agreements or investment agreements with government. The extent to which the target imports or exports product, and therefore its dealings with customs authorities, is important but often ignored government touch-point. This is especially the case for oil, gas and mining companies that need to move heavy, high-value equipment in and out of the host country.

What is the nature of their products, services and technology?Canada controls the export and transfer of goods services and technology, under both export control laws and economic sanctions. These measures are not restricted to military or nuclear items but include many commercial dual-use items used in industry every day, including goods, software and technology for relatively low-level encryption and decryption. Goods and technology controlled for export or transfer from Canada are set out on the Export Control List. Economic sanctions measures also impose similar requirements based on the nature of the goods and technology being supplied – for example, Canada’s sanctions against Iran prohibit the transfer to Iran of any items, including technical data, used in the petrochemical, oil or natural gas industry.

In addition to understanding what product and services your target ultimately provides to its customers, you should consider what inputs are used in the process, how product research and development occurs, and what, if any, after sales service and support is provided. Keep in mind that these controls are not limited to physical export shipments, but include cross-border transfers of information that occur via email transmissions and server upload/download activity or during technical discussions with persons outside of Canada.

What is the target’s exposure to similar measures of other jurisdictions?Depending on the circumstances, Canadian companies can be subject to anti-corruption and trade control laws of other jurisdictions. The US Foreign Corrupt Practices Act (FCPA) is notoriously enforced on a broad, extraterritorial basis often ensnaring Canadian companies that had considered themselves to have little connection to the United States. For example, a Canadian company that causes, directly or through agents, acts in furtherance of a corrupt payment to take place within the territory of the United States is subject to the jurisdiction of the FCPA.

The FCPA obligations are in large part similar to those in the CFPOA. However, the United Kingdom’s Bribery Act 2010 contains some important differences, including the prohibition of private commercial bribery and no exclusion for facilitation payments.

A number of US sanctions and export control measures are also applied on an extraterritorial basis, especially in dealings with Iran or Cuba. In the latter case, Canada has implemented blocking legislation designed to address issues such as US extraterritorial measures. Canadian law prohibits a Canadian company or individual from complying with the US sanctions and export controls on Cuba. This presents a challenging conflict of laws when the target is or will be US-owned or controlled – on the one hand, the company is required to comply with the US trade embargo while on the other hand, to do so will constitute an offence under Canadian law and expose the Canadian company and its officers to potential liability.

What compliance measures does the target have in place? Although there is seldom enough time in the heat of an M&A transaction to conduct a thorough audit of the target’s compliance with anti-corruption and trade controls, there are basic minimum steps that can be taken to get a good sense of the target’s compliance profile and potential exposure. Basic elements we expect to see in any anti-bribery, economic sanctions and export control compliance programs include the following: a written compliance manual and procedures, screening of transactions and all involved parties against lists of sanctioned or designated entities and individuals, appointment of compliance officers, internal compliance auditing, non-compliance reporting, correction and voluntary disclosure, training programs, contract and project review, and procedures for dealing with inconsistent or conflicting laws.

Obtaining a description of the target’s anti-bribery and trade control procedures and a copy of the compliance policy manuals is an obvious start, but it is not enough.

It is also critical to review evidence of implementation of these measures across the operation. For example, how often are employees and executives trained on these policies? When are internal audits conducted and what are the results? How often are potential non-compliance events being reported internally? Is an employee hotline being used and what kind of reports are being made? What voluntary disclosures have they submitted to government authorities? Have they been subject to government investigations or audits and with what results? What is their process for reviewing and determining the control status of their goods, services and technology and what rulings have they obtained in respect of the same? In what circumstances have they terminated or refused to retain agents because of bribery concerns? What specific provisions has the target included in their contracts to address anti-bribery and trade controls compliance? What compliance certifications do they have from business partners? How do they use third parties to assist in implementation of compliance measures – e.g., screening transactions, due diligence of agents, internal review and audit, legal opinions?

What next?

Responses to these initial inquiries inevitably beget more questions in this process and the back and forth continues as you drill down into areas of concern and potential exposure for the target and, ultimately, the acquirer. Risks may be so high that the deal is scrapped or at least delayed until they can be addressed through the implementation of enhanced compliance measures or disclosures to the authorities if necessary. In other cases, representations and warranties as well as appropriate indemnities may be sufficient to address any concerns. Once the transaction closes, however, it is important to immediately begin conducting a more thorough review of the target’s compliance based on potential areas of vulnerability identified during the pre-acquisition due diligence phase and addressing any potential non-compliance.

John W. Boscariol is Leader of the International Trade and Investment Law Group at McCarthy Tétrault LLP. He can be contacted on +1 (416) 601 7835 or by email: jboscariol@mccarthy.ca.          

Getting Your Company Ready for M&A Compliance Due Diligence

Who was the absolute worst general during the Civil War? While there are many worthy candidates for this dubious honor, on the Southern side my vote goes to General John Bell Hood. One of the prime proponents of the Southern attack and die strategy, Hood’s leadership led to the destruction of 90% of his Texas Brigade at Antietam. But Hood is most famous for his utter destruction of the Army of Tennessee. In five months, from July to November of 1864 Hood unsuccessfully attacked Union General William T. Sherman’s army three times near Atlanta, relinquished the city after a month-long siege, then took his army back to Tennessee in the fall to draw Sherman away from the Deep South. Sherman dispatched part of his army to Tennessee, and Hood lost two battles at Franklin and Nashville in November and December 1864. There were about 65,000 soldiers in the Army of Tennessee when Hood assumed command in July. By January 1, there were only 18,000 men in the army. To top it off, it was not Sherman who burned Atlanta but Hood.

My thoughts turned to General Hood when I listened to a very interesting panel on Day 2 of the ACI FCPA Boot Camp about getting your target company ready to be scrutinized from the compliance context in mergers and acquisition (M&A) due diligence. On the panel were Alberto Orozco from PricewaterhouseCoopers (PwC), Joseph Burke, from Dell Inc., and Christina Lunders from the law firm of Norton Rose Fulbright.

Building on a fundamental theme from day one of the conference, Burke said that relationship building is also important in the M&A context, from the perspective as a buyer. Representing an acquirer, the key questions from his perspective were two-fold: whether or not we trust the company we are looking at and how will they integrate into our company? He believed that trust is what gets the deal done or does not. He begins by sitting down with his counter-part, senior management and key legal department personnel in the target company and talking to them. If they can talk with authority about their compliance function he can determine how much he will dig into the documents and records.

Orozco agreed with this perception but came at it from his accounting angle. He said that if your books and records are in order, you really do not need to do anything more. The next step he looks at is if you have a compliance program and do the targets employees know about it. This is critical so that the buyer will have an understanding of what is needed from the compliance perspective from day one of the acquisition closing.

They then turned to the perspective of a target and what you should have in place for such an analysis. It all begins with a compliance focused risk assessment and this should be done first as this is a key starting point to determine not only if the target has an effective compliance program but also if the target is actually ‘doing compliance’. Of course it is important for a target to know about its relationships with foreign governments, whether as customers or representatives on the sales side or in the supply chain.

They posited that a target should make sure that it has a compliance program, which is consistent with an international standard for an anti-bribery or anti-corruption program, whether it is the Foreign Corrupt Practices Act (FCPA), UK Bribery Act or some other recognized international standard. The target should gather and verify the completeness of the following anti-corruption policies and procedures:

• Anti-corruption/anti-bribery;
• Petty cash;
• Travel, meals, and entertainment;
• Gifts, donations, sponsorships, political contributions, lobbying;
• Retention, use and compensation of intermediaries/third parties;
• Disbursements;
• Recording of intercompany transactions; and
• Authorization for expenditure/levels of authority.

They believe that it is important for a target to gather and verify the completeness of relevant books and records. They specifically listed the following:

• Monthly trial balances;
• Customer lists;
• Vendor lists;
• General ledger accounts for the following:
• Gifts, entertainment and hospitality;
• Travel;
• Donations, sponsorships, and political contributions;
• Marketing and commissions expenses;
• Consulting fees;
• Petty cash; and
• Miscellaneous expenses.

They next suggested the documents and records be readied for review from the compliance perspective, on the following topics:

• Facilitation payments;
• Advertising and marketing;
• Government tenders and bidding packages;
• Employee expense reports;
• Procurement;
• Licenses and permits;
• Records management;
• Transfer pricing; and
• Information on how policies/procedures are distributed and compliance acknowledged within the target organization.

Lastly, they provided a list of topics for which documents should be gathered and the target should be prepared to discuss early on with the compliance representative of the acquirer on the subject of any past corruption issues which may have arisen or been identified, together with their resolution. The target should be prepared to deliver factual details, relevant documents, and information on findings and how the matters were resolved. This group of documents should include internal or external reviews, audits or investigations over the past ten years, including any outstanding compliance issues, such as whistleblower and hotline complaints.

In the area of corporate governance they suggested that the target gather Board of Directors and any management meeting minutes from the past five years and have them available for review. A target should also be prepared to make available for interview key personnel including the General Counsel (GC), Chief Financial Officer (CFO), Chief Executive Officer (CEO) and the heads of Internal Audit, International Sales and Compliance.

From the perspective of the acquiring entity, they suggested that you take a close look at the files of as many of the target’s third parties as is reasonable for the size of the acquisition and the time frame you have. These include gathering and verifying the completeness of the following third party files: due diligence; contracts/agreements; records of compensation payment for past 5 years to determine whether compensation is reasonable, especially if in a high-risk area or for business involving foreign officials and, finally, make a determination of how to address any potential red flags.

They also discussed some of the potential red flags, which might be present in these documents. Some of these red flags could include a history of corruption in country where business occurs; numerous or frequent interactions with foreign officials; unusual payment patterns or arrangements with third parties or third parties which refuse to certify compliance, demand payment in cash, provide incomplete or inaccurate information, request payment made to someone else; a bank outside of country of domicile or is close with foreign government officials.

I thought Burke’s perspective was akin to trust but verify. He reiterated several times that it is reasonably straightforward to determine if a target company takes ‘doing compliance’ seriously. From there, you can use analytics to review the numbers and try and make a determination about obvious red flags and high-risk areas. This allows him to help to make a more accurate remediation plan to begin at closing. It also allows him to advise the business unit involved on what the cost for such integration would be, how long the business would be disrupted by such integration and the complexities of acquiring company’s compliance program implementation.

As to the cost for failing to do so, just think of the loss of the Army of Tennessee from the leadership of John Bell Hood.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

Expanding Your Compliance Decision-Making Tool Kit

There can be a variety of reasons why bad decisions get made in the corporate world. Last week I wrote about psychopaths in the C-Suite and Boardroom. Today I want to look at some less flamboyant, more mundane ways that a company might get into compliance hot water through poor decision making. In an article in the November issue of the Harvard Business Review, entitled “Deciding How to Decide”, authors Hugh Courtney, Dan Lovallo and Carmina Clarke reviewed how senior decision makers in a company might go about strategic decision making. One of the areas that they explored was how systemic roadblocks might get in the way of making a valid decision.

I found their discussion very interesting from the compliance perspective. The FCPA Guidance emphasized the need for companies to have a robust pre-acquisition due diligence process, in addition to a vigorous post-acquisition integration. The FCPA Guidance stated, “In the context of the FCPA, mergers and acquisitions present both risks and opportunities. A company that does not perform adequate FCPA due diligence prior to a merger or acquisition may face both legal and business risks. Perhaps most commonly, inadequate due diligence can allow a course of bribery to continue—with all the attendant harms to a business’s profitability and reputation, as well as potential civil and criminal liability.” But what are some of the biases which might prevent a company from making a good strategic decision even with adequate pre-acquisition due diligence. The authors set out five which I will explore in more detail.

When You Don’t Know What You Don’t Know

Under this bias, the authors believe that the decision maker’s ability to make accurate decisions is in large part based on “being able to accurately determine the level of ambiguity and uncertainty they face.” Unfortunately, just as compliance programs have to deal with humans and human fallibilities, strategic decision makers are subject to both “cognitive limitations and behavioral biases.” The authors note that “executives don’t know what they don’t know, but are happy to assume that they do.” It is this overconfidence in the ability to forecast uncertain outcomes that will lead to unwarranted confirmation of incorrect hypotheses.

Cognitive Bias Creep

Here the authors note that every corporation has biases and these biases can creep into any significant strategic decision. The key is that they manage these biases going forward so that they do not prevent an accurate decision from even having the chance of being made. The authors believe that this can be helped “if, when a strategic decision is being considered, managers choose their decision-making approach in a systematic, transparent, public manner during their judgments which can be evaluated by peers.” This concept is well established in any best practices compliance program through an oversight committee or other similar structure proving review of the compliance function. It is through these techniques that key players “are less likely to assume that their decisions are straightforward or even intuitive.” The authors conclude this section by stating that, “This is especially important when a relatively new or unique strategic investment is under consideration.”

Organizational Process Gets In the Way

I try to be a process guy and to be process oriented. I tend to believe that if you have a robust process in place, it can help you to greatly reduce, ameliorate or manage your compliance risks. The authors believe this as well but feel there are times when the organizational process of a company can get in the way of making a strategic decision. Fortunately many of the techniques to overcome this problem are relatively straight-forward. Although not phrased in this manner, one is the concept of segregation of duties (SODs). In other words, do not have the people who will benefit from a favorable analysis be the only group or discipline within the company to review a decision or even its underlying facts. The authors answer is to have some “commonsense protocols” which allow for an independent eye on things.

Reliance on a Single Tool

One of the areas that the authors maintain throughout their article is the criticism by decision makers on a single analytical tool. They believe that most corporate decision makers rely solely on “conventional capital-budgeting techniques.” They argue that it is most often more useful for decision makers to supplement this basic tool. They articulate that decision makers use other sources of insight. They are particularly critical of only looked to so-called ‘expert opinions’ and suggest that a company seek a wider group of opinions, even within the employee base of their own company. Another technique is to seek out persons in different disciplines simply because they will bring a different underlying analysis and perspective. The authors end this section by stating, “A robust analysis of analogous situations forces decision makers to look at their particular situation more objectively and tends to uncover any wishful thinking built into their return expectations.”

The Option to Delay

The final bias the authors address is the option that is often overlooked – the option to wait or as the authors put it “Deciding when to decide is often as important as deciding how to decide.” If you have ever been on a large project evaluating a merger or acquisition target or other business opportunity, you know that things can take on a momentum of their own. The authors call this “learning-based, iterative experimentation.” This is not a situation of sometimes the best deals are the ones you do not sign on to but deciding to use other tools or techniques to evaluate the timing of your decision making process. This can not only keep you from doing deals that may not make any sense but allow for a more well-rounded decision making process.

The clear message of the authors’ piece is that you should use a wider variety of tools available to you. The FCPA Guidance gives you some of the things that the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) think are important. In addition to the use of transaction, third party and relationship monitoring, I would suggest that you add some or all of the following tools to your toolkit.

• Review high risk geographical areas where your company and the target do business. If there is overlap, seek out your own sales and operational people and ask them what compliance issues are prevalent in those areas. If there are compliance issues that your company faces, then the target probably faces them as well.
• Obtain from the target a detailed list of sales going back 3-5 years, broken out by country. If you can obtain a further breakdown by product or services get that as well. You do not need to investigate de minimis sales amounts but focus your Foreign Corrupt Practices Act (FCPA) due diligence inquiry on high sales volumes in high risk countries.
• If the target uses a sales model of third parties, obtain a complete list, including joint ventures (JVs). It should be broken out by country and the amount of commission paid. Review all underlying due diligence on these foreign business representatives, their contracts and how they were managed after the contract was executed. But your focus should be on large commissions in high risk countries.
• You will need to speak to the target company personnel who are responsible for its compliance program to garner a full understanding of how they view their compliance program.
• You will need to review the travel and entertainment records of the target’s top sales personnel in high risk countries. You should retain a forensic auditing firm to assist you with this effort. Use the resources of your own company personnel to find out what is reasonable for travel and entertainment in the same high risk countries which your company does business.
• While always an issue fraught with numerous considerations, there may be others in the mergers and acquisition (M&A) context, such as any statutory obligations to disclose violations of any anti-bribery or anti-corruption laws in the jurisdiction(s) in question; what effect will disclosure have on the target’s value or the purchase price that your company is willing to offer.
• While you are performing the FCPA due diligence, you should also review issues for anti-money laundering (AML) and export control issues.

The moral of this story to use a wide variety of tools and resources when evaluating a strategic decision; whether it is compliance based or business based. Do not get caught in myopic thinking or analysis.

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Please join myself and Eddie Cogan, CEO of Catelas as we discuss Risk-Based 3rd Party Vetting, Screening and Monitoring Strategies for High Risk Jurisdictions Thursday, December 12. For information and registration click here.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2013

Pre-Acquisition Due Diligence Program for Evaluating Target Companies in M&A

I am just back from our nation’s capital attending the Society of Corporate Compliance and Ethics (SCCE) 2013 annual Compliance and Ethics Institute. If you have a chance to attend next year’s event in Chicago I urge you to do so. The sessions were first rate, topical and had great insights. The networking and sharing of information was also great. While the vendors were there to market their own products and services they were clearly part of the overall solution, so kudos to every company that showed at the event. Hats off to everyone on Team SCCE for doing a great job. Finally, to Roy Snell, Matt Kelly was right; you take the casual, hip look up to the next level, I wish I had your style.

One of the sessions I attended was entitled “Compliance Due Diligence In Multi-National Transactions: Mergers & Acquisitions and Third Parties”, led by Louis Perold, Legal Compliance Manager at Sasol Ltd., and Krista Muszak, Senior Compliance Analyst at Paychex, Inc. In this session, they laid out the steps that you should take when looking at an acquisition from the compliance perspective.

I.                   Review

They suggested a five step process which I thought was well laid out to show you how to plan and execute a strategy to perform pre-acquisition due diligence in the merger context. The process was as follows:

1. Establish a point of contact. Here you need to determine one point of contact that you can liaise with throughout the process. They suggested that typically this would be the target’s Chief Compliance Officer (CCO) if the company is large enough to have full time position.
2. Collect relevant documents. The documents suggested that you begin with are a detailed list of sales going back 3-5 years, broken out by country and, if possible, obtain a further breakdown by product and/or services; all JV contracts and due diligence on JVs and other third party business partners; the travel and entertainment records of the acquisition target company’s top sales personnel in high risk countries; internal audit reports and other relevant documents.
3. Review the compliance and ethics mission and goals. Here they said you should look at the Code of Conduct or other foundational documents that a company might have to gain some insight into what they publicly espouse.
4. Review the seven elements of an effective compliance program, as below:

A. Oversight and operational structure of the compliance program. Here you should assess the role of board, CCO and if there is one, the compliance committee. Regarding the CCO, you need to look at their reporting and access – is it independent within the overall structure of the company? Also, what are the resources dedicated to the compliance program including a review of personnel, the budget and overall resources?

B. Policies/Procedures, Code of Conduct. In this analysis you should identify industry practices and legal standards which may exist for the target company. You need to review how the compliance policies and procedures were developed and determine the review cycles for compliance policies, if any. Lastly, you need to know how everything is distributed and what are the enforcement mechanisms for compliance policies? The speakers pointed out that you should check with HR for terminations or discipline relating to compliance

C. Education, training and communication. Here you need to review the compliance training process as it exists in the company; both the formal and the informal. You should ask such questions as “What are the plans and schedules for compliance training?” Next determine if the training material itself is fit for intended purpose, including both internal and external training for third parties. You should also evaluate the training delivery channels. Is the compliance training delivered live, online, or through video? Finally, assess whether the company has updated their training based on changing of laws.

D. Monitoring and auditing. Under this section you need to review both the internal audit plan and methodology used regarding any compliance audits. A couple of key points are (1) is it consistent over a period of time and (2) what is the audit frequency? You should also try and judge whether the audit is truly independent or if there was manipulation by the business unit.

E. Reporting. What is the company’s system for reporting violations or allegations of violations? Is the reporting system anonymous? From there you need to then turn to who does the investigations and how are they conducted? A key here, as well as something to keep in mind throughout the process, is the adequacy of record keeping by the target.

F. Response to detected violations. This review is to determine management’s response to detected violations. What is the remediation that has occurred and what corrective action has been taken to prevent future, similar violations. Has there been any internal enforcement and discipline of compliance policies if there were violations? Lastly, what are the disclosure procedures to let the relevant regulatory or other authorities know about any violations and the responses thereto?

G. Enforcement Practices/Disciplinary Actions. Under this analysis, you need to see if there was any discipline delivered up to and including termination. If remedial measures were put in place, how were they distributed throughout the company and were they understood by employees?

5. Review the periodic evaluation of the program’s effectiveness. Under this they suggested a review of the target’s internal audit reports or outside investigations if they were performed.

II.        Red Flags

The speakers provided a short list of red flags that, should you determine exist, need to be further investigated and cleared. They listed the following:

• Ineffective compliance program elements
• Company in financial difficulty
• Frequent breach of policies and procedures
• Inactive compliance and ethics committee
• No access to the board
• No regular reports to the board
• CCO not allowed direct access to the Chief Executive Officer (CEO)
• Lack of independence
• Frequent requests to waive policies
• No consistent consequence management for violations

III.             Evaluation

The speakers also provided a ranking system which can be used to think through and evaluate the information that you have obtained. They proposed the following.

• Level 1 – Absent. There is no commitment to compliance illustrated by no dedicated resources, no formal compliance policy and the absence of a compliance program.
• Level 2 – Reactive. There is commitment to address compliance issues when major breaches arise.
• Level 3 – Foundational. While there is commitment to address compliance issues when major breaches arise, there is no formal compliance program but policies and monitoring activities are put in place to prevent the reoccurrence of major breaches.
• Level 4 – Proactive. There is a commitment to have a strong compliance program in place with dedicated resources and a clear assessment of all risk areas. The program encompasses ongoing monitoring and measurement as well as proactive and preventative elements.
• Level 5 – Embedded. The compliance program pervades the organization in every respect: strategically, culturally and operationally. Every staff member is aware of and takes appropriate responsibility for the effective implementation of the compliance program and its ongoing improvement.

I found their program a very useful session on how you should think through performing due diligence on a target in the acquisition context. With the Department Of Justice’s (DOJ’s) emphasis on pre-acquisition due diligence, as set out in last year’s FCPA Guidance, I think more companies will need to strengthen this portion of their compliance program.

And once again, a big thanks to SCCE for a great week at the Compliance and Ethics Institute 2013.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2013